Cintas: Earnings machine has a knack for re-invention

Cintas Corp., whose trucks you may have seen rumbling through the streets of your city, has been primarily known for renting uniforms since its founding in 1968.

But dropping off freshly pressed garments to customers is now estimated to constitute less than half of its business. Cintas has added restroom products, meaning you may see its name and its Sanis brand on a paper-towel dispenser. It has expanded into first aid and safety products, as well as document-shredding services. According to a recent press release, the wave of new products continues: "Cintas Introduces GlucoBurst for Diabetes Management in the Workplace."

Cintas is now pulling in more than a billion dollars in sales per quarter – much of it thanks to its seemingly endless ability to find new offerings for its customers to buy.

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This week, though, it released moderately disappointing earnings and announced annual guidance at the lower end of analyst expectations, sending its shares sliding. While the stock hasn't become cheap – it still trades at a healthy premium to the overall market – it may be time to buy in to the Cintas earnings machine.

To be fair, the Cincinnati-based company (hence the "Cin" in "Cintas") has provided reason for caution. In the just-completed fourth quarter, customers rented fewer uniforms than before because of lower employment.

The choppy economy continues to act as a headwind because the performance of Cintas's core uniform-rental business is tied to the U.S. jobs picture (and, to a much lesser extent, Canada's.)

Cintas, however, has a history of coping well with problems. Barbara Noverini, an analyst with Morningstar Equity Research who puts a "fair value" of $37 on the shares, notes the company's return on invested capital averaged 14.5 per cent over the past decade – nearly twice that produced by uniform competitor G&K Services – and didn't fall below its cost of capital even during the worst of the 2008-09 recession.

Ms. Noverini says this reveals the advantage that Cintas enjoys compared to its peers. It can use its vast scale to absorb volatile costs for fuel, labour and apparel fibre by negotiating favourable pricing from suppliers and spreading costs over its large base. "This allows the company to operate more flexibly than players under the burden of razor-thin profit margins," she avers.

Andrew Wittmann, an analyst with R.W. Baird who has a "neutral" rating and $41 price target on Cintas shares, notes the company's hygiene business, which includes the Sanis products as well as floor-cleaning services, has grown at an average annual rate of 13.2 per cent over the past five years. Another line of work, document management, already represents 8.3 per cent of the company's total revenue and enjoys lush margins. Cintas is already the second largest player in the industry, tied with Shred-It and behind No. 1 Iron Mountain.

These "non-core" business lines are now about 50 per cent of total revenue, Mr. Wittmann notes, "and are all showing generally good momentum. We believe these growth lines are often overlooked by investors, despite (we believe) attractive contribution margins and relatively low capital requirements for growth."

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So is it time to rush out and buy Cintas? Wait just a second. Before this week's slight decline, Cintas was trading at about a 24 per cent premium to the S&P 500, based on its share price to earnings and share price to free cash flow, according to Gary Bisbee of Barclays Capital. Many analysts, recognizing the relatively generous valuation, the uncertain U.S. economy, and management's cautious guidance, are very comfortable with "hold" ratings at the current levels.

All of that suggests the short-term upside for Cintas shares may well be muted. Investors, though, should keep an eye on the shares over the course of the summer for further declines. Mr. Wittmann, the analyst, says he "could turn more constructive in the low-[to-]mid $30s."

Given Cintas' earnings track record and capacity for new ways to wring sales out of its customer base, I suspect that a couple years from now we could look back wistfully at the opportunity to buy shares for less than $40 – as we eye yet another basket of new offerings for Cintas's customers to buy.

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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